East Africa’s Energy Boom

Gas discoveries in Mozambique and Tanzania, and rising estimates for oil in Uganda, Kenya, Ethiopia and Puntland, are attracting global energy companies to east Africa.

In July, European Commission president José Manuel Barroso and Andris Piebalgs, European development commissioner, visited Mozambique and Tanzania to bolster financing in a region where European companies including Royal Dutch Shell, Cove Energy, ENI, Galp Energia and BG Group are making inroads.

The same month, Brian Dames, CEO of South Africa’s Eskom, pledged to pursue more cross-border electricity projects with Electricidade de Moçambique. “East Africais a very exciting place to be, which is very positive for the region as a whole,” says Paul McDade, COO of Tullow Oil, an Irish company with a run of successes across the continent.

Attention now turns to the speed and ease with which East Africa’s oil and gas can be brought to market. Coastal countries have strong prospects, with direct links toAsia. Plans to build a liquefied natural gas terminal in Mozambique mean exports to the Asian market could begin by 2018. The upside estimates for discovered gas are around 100 trillion cubic feet, provoking energy behemoth Royal Dutch Shell to negotiate a $2bn takeover of Cove Energy, currently the main player in Mozambique, although it lost the bidding war to PTT of Thailand.

Mozambique is also positioned to be a regional power exporter, providing gas to southern African countries as well as converting gas into electricity and selling across borders. Scottish firm Aggreko recently signed a $250m deal to provide a 107MV power plant to supply Mozambique and South Africa, making it the first private firm to supply power cross-border to utilities in southern Africa, and underscoring Mozambique’s importance as a regional energy hub. Infrastructure constraints remain huge, however, with Mozambique’s government estimating that $50bn will be required to develop export infrastructure.

Coastal Kenya is also well-poised to export oil, should commercial production be realised from recent discoveries in the northwest Turkana region, which are potentially more substantial than Lake Albert’s oil in Uganda. Unlike Uganda, Kenya has access to the sea, quickening its route to export, although its neighbour may benefit too.

“From a regional perspective, if Kenya has a pipeline from northern Kenya to the coast, in Uganda there are great synergies, with respect to joining up with that pipeline,” says Tullow’s Mr McDade. He believes companies can play a constructive role. “Kenya has been looking at infrastructure ideas even before we discovered oil, so as a company we have to listen to host governments and register their objectives and ideas, and what they are trying to achieve. We can then use our expertise to fulfill these objectives and hopefully there will be alignment with ours.”

Those developments are speculative, however. “No decision has been made on an export pipeline yet, and it is not until early 2013 that we expect to get to a mutually agreed view on what future development will look like,” notes Eoin Mekie, general manager of Tullow Oil’s Ugandan operation.

East Africa’s energy integration will hinge largely on progress in the creation of a port in Lamu – an island off Kenya’s northern coast. That development is a central component of Kenya’s Vision 2030 strategy, featuring a planned infrastructure project, the Lamu-South Sudan-Ethiopia Transport Corridor, connecting Ethiopia, Uganda and South Sudan. The latter could be a major supplier, although its oil reserves currently remain underground following a dispute with Sudan over transit fees – for which Khartoum was charging 10 times the going rate. At the time of press, Juba had reached a tentative agreement withSudanover export fees, but there was no indication of when production would resume.

Oil constitutes 98 percent of Juba’s budget and South Sudan has an interest in accessing regional pipelines and infrastructure, offering an export route and minimising reliance on Sudan. “We still depend on others. Our liberty today is incomplete…We must be more than liberated. We have to be independent economically,”South Sudan’s president Salva Kiir said at an independence day rally.

Rival mentality

But while the development of regional infrastructure will greatly aid production, there are questions over the degree to which energy companies and governments will be able to work smoothly together. At the state level, bureaucratic inertia is considerable, and bilateral relations are not yet cordial enough to allow straightforward deal-making. “My sense is that there hasn’t been the kind of cooperation across the borders that might be required,” says Philippe de Pontet, Africa risk analyst at Eurasia Group. “These governments are not at loggerheads in any way, but there is a mentality of rivalry and a zero sum game.”

Refining poses another challenge. Governments have been keen to ensure domestic oil can be processed within their countries, creating jobs and reducing imports. But refining involves significant scale economies and Africa’s rising producers are likely to have high-cost refining sectors. “Exporting [fuel] products is more problematic than exporting crude,” argues Anish Kapadia, analyst at Tudor, Pickering, Holt & Co, an energy investment bank. “It makes more sense to export the crude and for governments to take direct profits from it.”

Despite this, the Ugandan government has been bullish. Irene Muloni, Ugandan minister for energy and mineral development, insisted “a refinery will be built”, a prediction echoed by Tullow’s Eoin Mekie. But Tullow, Total and CNOOC, the international oil companies operating in the country, have not pledged funds to the refinery project, and any development is likely to remain small-scale following the discoveries inKenya, which strengthen the case for a pipeline. Developing a regional refinery would be another possibility.

Legal groundwork

Meanwhile, companies are growing fat off their East Africa adventures. AfricaOil, previously a little known Canadian oil and gas company, is now valued at almost $2bn following an onshore discovery in Kenya. Tullow Oil has grown substantially after a string of wins, and has now sold exploration blocks in Uganda to Total and CNOOC for $2.9bn. Cove Energy, a Mozambique-focused mineral exploration company, has been subject to a $1.8bn takeover by Thai company PTT Exploration and Production after Royal Dutch Shell dropped out of a bidding war. The competition speaks volumes about the value of Mozambique’s gas finds.

But as money floods in, questions are emerging over whether governments are capable of assembling a steady regulatory climate. In 2011, Heritage Oil, the Ugandan government and Tullow Oil entered a three-way legal dispute over $435m of capital gains tax. The issue remains unresolved in British courts and has delayed Uganda’s commercial production.

Indications from Mozambique are encouraging for investors, with the government resisting the temptation to change its rules now that the full scale of its resources is known. A review of the country’s Petroleum Law is set to be concluded in 2013, and will not see any changes to the fiscal regime, instead focusing on emerging subsectors and gas infrastructure.

“Investors come to our country and risk their own money. Sometimes they are investing in the dark. They drill to find gas or to find oil but those drillings result in nothing and they come out dry. It’s their risk, so when they find something that allows them to make money we should respect the rules that have been established,” says Salvador Namburete, the country’s energy minister.

There is, of course, pressure to show measurable developmental results, but that takes time. “There is a debate going on in Mozambique at the moment regarding the contribution of mega-projects to the development of the country. This is a debate that is being promoted by the opposition. We are discussing, we are debating their arguments,” he says. “We do think it’s important that we have a better share of what is being produced or extracted from our country but it has to be on the basis of a negotiation with investors. We cannot change the rules of the game overnight. That’s not good for private investment in the country.”

Mr Namburete is also clear that while gas finds will deliver major revenues, these are slow in coming, and cannot be lavished on the country immediately. “We cannot spend what we have not collected. We have to be very careful in the planning process, to make sure revenue is really going to materialise before we plan how to spend it.”

In part, that requires improved public communication. “We have a big responsibility of explaining to the Mozambique people that while there is news that natural gas has been found, from discovery to production it may take five, eight, nine, 12, 15 years. We’ve been running some campaigns to educate people to understand that there’s a lot of companies that have invested in the discovery of those resources but the real benefits will not come today, the benefits will come in the medium- to long-term.”

Expectations – and needs – are even higher in the north of the region, where South Sudan, which recently marked its first birthday in sombre mood, dangles perilously close to an economic abyss after its oil shutdown. Prior to that decision, the South Sudanese had, on paper, a higher GDP per capita ($1,500) than their neighbours – double that of Kenya and triple that of Uganda – with an annual budget in 2011 of $2.3bn. Yet after its controversial decision to freeze production, the government is run ragged as it seeks to erect a new state under the most inclement of circumstances.

In Uganda, the challenge is to construct a sufficiently robust framework to manage the major investments with minimal legal conflict. Bills are currently in parliament to clarify the sharing of royalties, the licensing process and ensure a competitive environment. But their passage through parliament is rocky, and corruption allegations are rife.

Tanzania, meanwhile, is angling to tighten the gas sector’s fiscal and regulatory regime. Changes are likely to include undefined increased fees and royalty rates (currently at 12.5 percent), the country’s energy and minerals minister, Sospeter Muhongo has said in parliament. The draft framework is yet to be disclosed.

Even with solid legislation in place, there are macroeconomic challenges for the region. One concern is currency appreciation, which could affect the functioning of a regional common currency, should one ever emerge. WithKenyaapproaching testy elections, major oil revenues will do little to calm the politics.

As more big energy companies sink wells into East Africa, the continent’s oil and gas-rich geology will continue to bear fruit. An eye on Asian demand – still far from maturity – suggests a regional approach could benefit all involved.

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